You’ve probably heard that you should account for inflation when tweaking your finances. This is because inflation makes things more expensive and weakens your money’s capacity to buy goods and services.
But what does it really mean to budget for inflation? Is there a formula to follow? In this guide, you’ll find an overview of how to account for inflation in your budget.
Step 1: List down your expenses
Inflation can impact every person’s budget differently depending on what they spend on. That’s why it’s important to track and list down your expenses.
Some categories are more affected by inflation than others. Here are two types of expenses to identify:
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Fixed expenses
These are items that are less likely to change in price within a short period. They could include your rent, housing loan, car loan, and insurance payments.
It’s easier to budget for these costs since they rarely change from month to month. They are largely unaffected by inflation, at least in the short term.
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Variable expenses
Prices tend to change a lot with these expenses, and they are the most affected by inflation. Variable costs include groceries, utilities, transportation, and clothing, among others.
If you want to reduce expenses to beat the effects of inflation, it’s easier to start with variable costs. Fixed expenses can be harder to change and lowering them may require major lifestyle adjustments.
Step 2: Understand inflation rates and the Consumer Price Index
Governments and central banks measure headline inflation (or deflation) using a tool called the Consumer Price Index (CPI). Find out what it is below.
What is the Consumer Price Index?
The CPI tracks changes in the price of a standard “basket” of goods and services that a typical family spends on. This basket can include a lot of things, from clothes, to fuel, and even dining out at a restaurant.
In the Philippines, the CPI excludes certain items like gifts, charitable spending, and some secondhand products. The government releases CPIs for the entire country as well as specific indices for different regions or cities.
These indices are used to calculate the inflation rate, which is the rate of change in the CPI. They also show the purchasing power of the peso, or how much the peso is worth based on what it can buy at a given time.
You’ll find the annual and monthly inflation rates and CPIs on the Philippine Statistics Authority’s (PSA) website. It helps to know these numbers when adjusting your budget for inflation.
Step 3: Adjust your budget to account for inflation
Here’s where you need to do a little bit of math. Take note that you’ll only learn the actual inflation rate for a month or a year once it’s over.
There are reports that forecast inflation rates and the government also sets a target range. You may need to use your best judgment and make an estimate based on historical data and experts’ predictions.
For example, if the annual inflation rate has been around 3% over the past few years, you can consider increasing your budget by the same amount next year.
Another way to budget for inflation is to lower your costs. You may need to look for cheaper alternatives if you want to keep allocating the same amount of money to expenses even when prices are rising.
Step 4: Revisit savings and investments
Don’t forget to account for inflation when setting or reviewing your savings and investing goals. If your investments are not rising as fast as inflation, your actual inflation-adjusted earnings may be lower than you expect.
You’ll also need to revisit your emergency fund. Make sure that you put more money in it to cover an increase in utilities, healthcare costs, and other necessities.
When you account for inflation in your budget, you’ll have a clearer view of your finances. You’ll also have higher chances of reaching your money goals since you have a better idea of what it takes to achieve them.
